Netflix Subscriber Numbers Up, but Streaming Still Short on Profits

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Netflix Subscriber Numbers Up, but Streaming Still Short on Profits

Netflix's fourth-quarter earnings show that the company has staunched the bleeding of total domestic subscribers that sent it into a tailspin last quarter. But gains in streaming subscriber numbers in the U.S. and worldwide can't hide that the bulk of the company's profits still come from its U.S.-only DVD-by-mail business, where subscribers are sharply down.

Total domestic subscriptions are now 24.4 million, up from 23.79 million last quarter (and 19.5 million a year ago). But total domestic subscriptions don't actually offer a terrifically helpful picture of Netflix's business. It's a little like if Apple only touted how many total device customers it had, without breaking down sales of iPods, iPhones, iPads or Macs.

That 24.4 million includes 21.67 million streaming subscriptions in the US (just slightly up from 21.45 million last quarter) and 11.17 million DVD-by-mail subscriptions — which is quite sharply down from 13.93 million last quarter. Still, those DVD-by-mail subscriptions contributed $194 million of profit on only $370 million in revenue. Streaming, meanwhile, brings in $476 million in revenue, but only nets $52 million for Netflix's bottom line.

In other words, the company's pricing changes are still causing them to lose customers – and its most profitable ones at that. Subscribers who once had packages of up to four DVDs are either scaling back to inexpensive streaming-only plans or leaving Netflix altogether.

Meanwhile, Netflix's expensive content deals, plus infrastructure and software costs, eat up the bulk of the revenue that the huge number of streaming subscriptions brings in. And those comparatively tiny profits certainly can't cancel out the huge loss in potential profit those extra 2.76 million DVD subscriptions would have brought in.

Outside the US, meanwhile, Netflix is streaming-only — and still not profitable at all. Netflix lost $60 million on its international streaming business last year, with slightly under 2 million subscribers — a loss that more than cancels out its total profit from all 21.67 million US streaming customers.

Netflix is still in a powerful position relative to its competitors in video streaming. The company's letter to investors thinks its commercial-free streaming offerings are more attractive than Hulu's or Amazon's — although Netflix's CEO Reed Hastings and CFO David Wells reveal that they "expect Amazon to continue to offer their video service as a free extra with Prime domestically but also to brand their video subscription offering as a standalone service at a price less than ours."

You can also see the gain in streaming subscriptions and loss of DVD subscriptions as an affirmation of Hastings' strategy. Clearly, more of Netflix's customers are gravitating towards streaming and away from discs-by-mail. And Netflix contends this will only continue to be the case.

“We expect DVD subscribers to decline steadily every quarter, forever," said Netflix CEO Reed Hastings in a conference call with analysts on Wednesday.

The open question is whether Netflix brilliantly anticipated this trend or helped to elicit it through its pricing changes and Qwikster-sized marketing blunders.

Ultimately, though, Netflix isn't competing with itself or even with Hulu and Amazon – it's competing for your all TV viewers' last $8-10. This is why, as Hastings and Wells' letter notes:

[W]e see the biggest long term threat as TV Everywhere, and in particular, HBO GO, the leading implementation of TV Everywhere to date. HBO has some great content, particularly their original series, but today for most people it is locked behind a linear interface, or at best, behind a DVR interface and in all cases tethered to a linear subscription plan.

As HBO GO grows and becomes the primary way that consumers experience HBO, it will become a much more effective competitor for viewing time. Similarly, Showtime’s TV Everywhere application is very impressive and just starting to gain traction. Every major network is investing in their Internet application, on tablets, smart TVs, phones, game consoles, and laptops. Pricing is simple: the consumer just authenticates with their MVPD provider.

Over the next few years, UIs will evolve in astounding ways, such as allowing viewers to watch eight simultaneous games on ESPN, color coding where the best action is in a given moment or allowing Olympics fans the ability to control their own slow-motion replays. A decade from now, choosing a linear feed from a broadcast grid of 200 channels will seem like using a rotary dial telephone.

This is a powerful vision of the future of entertainment, and it's one that many of us would welcome.

Netflix's problem is that, just like HBO, ESPN or Amazon, its core business has also historically been tied to legacy media, albeit one delivered and managed in innovative ways. And while the number of HBO linear TV subscribers, ESPN linear TV viewers, and Amazon Prime shoppers have remained strong, giving each of those companies a solid, profitable base they could use to fund innovation, Netflix's DVD subscribers are dropping.

Unless Netflix can find a way to get its streaming subscriptions back to the same rate of revenue and customer growth it enjoyed for most of 2010 and 2011, the profit loss from slumping DVD subscriptions will be an albatross around its neck. Netflix, the great innovator of streaming video content, could win the argument and lose the war.